Raja Shekar Reddy

8/3/2019 Raja Shekar Reddy

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1.1 INTRODUCTION

The research methodology is the conceptual structure within which the research is

conducted.

1.2 TITLE:

A COMPREHENSIVE STUDY ON MONEY MARKET.

1.3 NEED AND SCOPE OF THE STUDY:

The need for a money market arises because receipts of economic units do not

coincide with their expenditures. These units can hold money balances to insure that planned

expenditures can be maintained independently of cash receipts (that is, transactions balances in

the form of currency, demand deposits, or NOW accounts). There are however, costs in the form

of foregone interest involved, by holding these balances. To enable the economic units to

minimize this cost, they usually seek to hold the minimum money balances required for day-to-

day transactions. They supplement these balances with holdings of money market instruments.

The advantages of money market instruments are: that it can be converted to cash quickly and at

a relatively low cost, and it have low price risk due to their short maturities. Economic units can

also meet their short-term cash demands by maintaining access to the money market and raising

funds there when required.

1.4 OBJECTIVES OF THE STUDY:

To know about the money market To identify how money market is functioning The growth of the money market in India The importance of money market


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SCOPE OF THE STUDY:

The India money market is a monetary system that involves the lending and borrowing of short-

term funds. India money market has seen exponential growth just after the globalization initiative

in 1992. It has been observed that financial institutions do employ money market instruments for

financing short-term monetary requirements of various sectors such as agriculture, finance and

manufacturing. The performance of the India money market has been outstanding in the past 20

years.

1.5 LIMATITATION OF THE STUDY:

It is one time study.


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WHAT DOES FINANCIAL MARKET MEAN?

Broad term describing any marketplace where buyers and sellers participate in the

trade of assets such as equities, bonds, currencies and derivatives. Financial markets are typically

defined by having transparent pricing, basic regulations on trading, costs and fees and marketforces determining the prices of securities that trade.

TYPES OF FINANCIAL MARKETS

A financial market consists of two major segments;

(a) Capital market and

(b) money market

While the money market deals in short-term credit, the capital market handles the

medium term and long-term credit.

Capital Market differs from money market in many ways. Firstly, while money market is Related

to short-term funds, the capital market related to long term funds. Secondly, while Money market

deals in securities like treasury bills, commercial paper, trade bills, deposit Certificates, etc., the

capital market deals in shares, debentures, bonds and government Securities. Thirdly, while the

participants in money market are Reserve Bank of India, Commercial banks, non-banking

financial companies, etc., the participants in capital market.

Are stockbrokers, underwriters, mutual funds, financial institutions, and individual investors.

Fourthly, while the money market is regulated by Reserve Bank of India, the capital market is

regulated by Securities Exchange Board of India (SEBI)

Let us discuss these two types of markets in detail

Capital Market may be defined as a market dealing in medium and long-term funds. It is An

institutional arrangement for borrowing medium and long-term funds and which provides

Facilities for marketing and trading of securities. So it constitutes all long-term borrowings from

banks and financial institutions, borrowings from foreign markets and raising of capital by issue


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various securities such as shares debentures, bonds, etc. In the present chapter let us discuss

about the market for trading of securities.

The market where securities are traded known as Securities market. It consists of two different

segments namely primary and secondary market. The primary market deals with new or freshissue of securities and is, therefore, also known as new issue market; Whereas the secondary

market provides a place for purchase and sale of existing securities and is often termed as stock

market or stock exchange.

PRIMARY MARKET:

The Primary Market consists of arrangements, which facilitate the procurement of long term

funds by companies by making fresh issue of shares and debentures. You know that companies

make fresh issue of shares and/or debentures at their formation stage and, if necessary,

subsequently for the expansion of business. It is usually done through private placement to

friends, relatives and financial institutions or by making public issue.

the companies have to follow a well-established legal procedure and involve a number of

intermediaries such as underwriters, brokers, etc. who form an integral part of the Primary

market. You must have learnt about many initial public offers (IPOs) made recently by a number

of public sector undertakings such as ONGC, GAIL, NTPC and the private Sector companies

like Tata Consultancy Services (TCS), Biocon, Jet-Airways and so on.

SECONDARY MARKET

The secondary market known as stock market or stock exchange plays an equally important role

in mobilizing long-term funds by providing the necessary liquidity to holdings in shares and

debentures. It provides a place where these securities can be encased without any difficulty and

delay. It is an organized market where shares and debentures are traded regularly with high

degree of transparency and security. In fact, an active secondary market facilitates the growth of

primary market as the investors in the primary market are as soured of a continuous market for

liquidity of their holdings. The major players in the primary market are merchant bankers,

mutual funds, financial institutions, and the individual investors; and in the secondary market

you have all these and the stockbrokers who are members of the stock exchange who facilitate


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the trading. After having a brief idea about the primary market and secondary market let see the

difference between them.

The main points of distinction between the primary market and secondary market are as follows:

1. Function:While the main function of primary market is to raise long-term funds through

fresh issue of securities, the main function of secondary market is to provide continuous

and ready market for the existing long-term securities.

2. Participants:While the major players in the primary market are financial institutions, mutual

funds, underwriters and individual investors, the major players in secondary market are

all of these and the stockbrokers who are members of the stock exchange.

3. Listing Requirement:While only those securities can be dealt with in the secondary market, which have

been approved for the purpose (listed), there is no such requirement in case of primary

market.

4. Determination of prices:In case of primary market, the prices are determined by the management with due

compliance with SEBI requirement for new issue of securities. But in case of secondary

market, the price of the securities is determined by forces of demand and supply of the

market and keeps on fluctuating.


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Introduction of Money Market

Whenever a bear market comes along, investors realize (yet again!) that the

stock market is a risky place for their savings. It's a fact we tend to forget while enjoying the

returns of a bull market! Unfortunately, this is part of the risk-return tradeoff. To get higherreturns, you have to take on a higher level of risk. For many investors, a volatile market is too

much to stomach - the money market offers an alternative to these higher-risk investments.

Definition of Money Market:

Market for short-term debt securities, such as banker's acceptances, commercial

paper, repos, negotiable certificates of deposit, and Treasury Bills with a maturity of one year or

less and often 30 days or less. Money market securities are generally very safe

investments which return a relatively low interest rate that is most appropriate for temporary cash

storage or short-term time horizons. Bid and ask spreads are relatively small due to the

large size and high liquidity of the market.

Definition of Capital Market:

A financial market that works as a conduit for demand and supply of debt and equity

capital. It channels the money provided by savers and depository institutions (banks, credit

unions, insurance companies, etc.) to borrowers and investees through a variety of financial

instruments (bonds, notes, shares) called securities.

A capital market is not a compact unit, but a highly decentralized system made up of three

major parts:

(1) Stock market,

(2) Bond market, and

(3) Money market.It also works as an exchange for trading existing claims on capital in the form of shares.


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Money Market Vs. Capital Market:

Basically the difference between the capital markets and money markets is that

capital markets are for long term investments, companies are selling stocks and bonds

in order to borrow money from their investors to improve their company or topurchase assets. Whereas money markets are more of a short term borrowing or

lending market where banks borrow and lend between each other, as well as finance

companies and everything that is borrowed is usually paid back within thirteen

months.

Another difference between the two markets is what is being used to do the

borrowing or lending. In the capital markets the most common thing used is stocks

and bonds, whereas with the money markets the most common things used are

commercial paper and certificates of deposits.

Features of Money Market:

The following are the general features of a money market:

1. It is market purely for short-term funds or financial assets called near money.2. It deals with financial assets having a maturity period up to one year only.3. It deals with only those assets which can be converted into cash readily without loss and with

minimum transaction cost.

4. Generally transactions take place through phone i.e., oral communication. Relevant documentsand written communications can be exchanged subsequently. There is no formal place like stock

exchange as in the case of a capital market.

5. Transactions have to be conducted without the help of brokers.6. The components of a money market are the Central Bank, Commercial Banks, Non-banking

financial companies, discount houses and acceptance house. Commercial banks generally play a

dominant in this market.


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Objectives:

The following are the important objectives of a money market:

To provide a parking place to employ short-term surplus funds. To provide room for overcoming short-term deficits. To enable the Central Bank to influence and regulate liquidity in the economy through its

intervention in this market.

To provide a reasonable access to users of Short-term funds to meet their requirements quickly,adequately and at reasonable costs.

Characteristic features of a developed Money Market:

In every country of the world, some type of money market exists. Some of them are

highly developed while others are not well developed. Prof. S.N. Sen has described certain

essential features of a developed money market.

1. Highly organized banking system: The commercial banks are the nerve centre of the wholemoney market. They are principal suppliers of short-term funds. Their policies regarding loans

and advances have impact on the entire money market. The commercial banks serve as vital link

between the central bank and the various segments of the highly organized banking system co-

exist. In an underdeveloped money market, the commercial banking system is not fully

developed.

2. Presence Of A Central Bank: The Central Bank acts as the bankers bank. It keeps their cashreserves and provides them financial accommodation in difficulties by discounting their eligible

securities. In other words, it enables the commercial banks and other institutions to convert their

assets into cash in times of financial crisis. Through its open market operations, the central bankabsorbs surplus cash during off-seasons and provides additional liquidity in the busy seasons.

Thus, the central bank is the leader, guide and controller of the money market. In an

underdeveloped money market, the central bank is in its infancy and not in a position to

influence and control the money market.


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3. Availability of Proper Credit Instruments: It is necessary for the existence of a developedmoney market a continuous availability of readily acceptable negotiable securities such as bills

of exchange, treasury bills etc. in the market. There should be a number of dealers in the money

market to transact in these securities. Availability of negotiable securities and the presence of

dealers and brokers in large numbers to transect in these securities are needed for the existence

of a instruments as well as dealers to deal in these instruments in an underdeveloped money

market.

4. Existence of Sub-Markets: The number of sub-markers determines the development of amoney market. The lager the number of sub-makers, the broader and more developed will be the

structure of money market. The several sub-makers together make a coherent money market. In

an underdevelopment money market, the various sub-makers, particularly the bill market, are

absent. Even of sub-makers exist, there is no co-ordination between them. Consequently,

different money rates prevail in the sub-makers and they remain unconnected with of funds.

5. Ample Resources: There must be availability of sufficient funds to finance transactions in thesub-makers. These funds may come from within the country and also from foreign countries.

The London, New York and Paris money markets attract funds from all over the world. The

underdeveloped money markets are starved of funds.

6. Existence of Secondary Market:There should be an active secondary market in theseinstruments.

7. Demand And Supply Of Funds: There should be a large demand and supply of short-termfunds. It presupposes the existence of a large domestic and foreign trade. Besides, it should have

adequate amount of liquidity in the form of large amounts maturing within a short period.

8. Other factors: Besides the above, other factors also contribute to the development of a moneymarket. Rapid industrial development leading to the emergence of stock exchange, large volume

of international trade leading to the system of bills exchange, political stability, favorable

conditions for foreign investment, price stabilization etc. are the other factors that facilitate the

development of money market in the country.


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London Money Market is a highly developed money market because it satisfies all requirements

of a developed money market. If any one or more of these factors are absent, then the money

market is called an underdeveloped one.

Importance of Money Market

A developed money market plays an important role in the financial system of a

country by supplying short-term funds adequately and quickly to trade and industry. The money

market is an integral part of a countrys economy. Therefore, a developed money market is

highly indispensable for the rapid development of the economy. A developed money market

helps the smooth functioning of the financial system in any economy in the following ways:

Development Of Trade And Industry: Money market is an important source of financingtrade and industry. The money market, through discounting operations and commercial papers,

finances the short-term working capital requirements of trade and industry and facilities the

development of industry and trade bothnational and international.

Development Of Capital Market: The short-term rates of interest and the conditions thatprevail in the money market influence the long-term interest as well as the resource

mobilization in capital market. Hence, the development of capital depends upon the existence

of a development of capital money market.

Smooth Functioning of Commercial Banks: The money market provides the commercialbanks with facilities for temporarily employing their surplus funds in easily realizable assets.

The banks can get back the funds quickly, in times of need, by resorting to the money market.

The commercial banks gain immensely by economizing on their cash balances in hand and at

the same time meeting the demand for large withdrawal of their depositors. It also enables

commercial banks to meet their statutory requirements of cash reserve ratio (CRR) and

Statutory Liquidity Ratio (SLR) by utilizing the money market mechanism.

Effective Central Bank Control: A developed money market helps the effective functioningof a central bank. It facilities effective implementation of the monetary policy of a central bank.

The central bank, through the money market, pumps new money into the economy in slump

and siphons if off in boom. The central bank, thus, regulates the flow of money so as to

promote economic growth with stability.


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Formulation Of Suitable Monetary Policy: Conditions prevailing in a money market serve asa true indicator of the monetary state of an economy. Hence, it serves as a guide to the

Government in formulating and revising the monetary policy then and there depending upon

the monetary conditions prevailing in the market.

Non-Inflationary Source Of Finance To Government: A developed money market helps theGovernment to raise short-term funds through the treasury bills floated in the market. In the

absence of a developed money market, the Government would be forced to print and issue

more money or borrow from the central bank. Both ways would lead to an increase in prices

and the consequent inflationary trend in the economy.

Composition of money market:

The money market is not a single homogeneous market. It consists of a number of sub-

markets which collectively constitute the money market. There should be competition within

each sub-market as well as between different sub-markets. The following are the main sub-

markets of a money market:

Call Money Market. Commercial Bills Market or Discount Market. Acceptance Market. Treasury bill Market.

Call Money Market:The call money market refers to the market for extremely short period loans; say one day

to fourteen days. These loans are repayable on demand at the option of either the lender or the

borrower. As stated earlier, these loans are given to brokers and dealers in stock exchange.

Similarly, banks with surplus lend to other banks with deficit funds in the call money market.Thus, it provides an equilibrating mechanism for evening out short term surpluses and deficits.

Moreover, commercial bank can quickly borrow from the call market to meet their statutory

liquidity requirements. They can also maximize their profits easily by investing their surplus

funds in the call market during the period when call rates are high and volatile.
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Operations in Call Market:

Borrowers and lenders in a call market contact each other over telephone. Hence, it is basically

over-the-telephone market. After negotiations over the phone, the borrowers and lenders arrive at

a deal specifying the amount of loan and the rate of interest. After the deal is over, the lender

issues FBL cheque in favor of the borrower. The borrower is turn issues call money borrowing

receipt. When the loan is repaid with interest, the lender returns the lender the duly discharges

receipt.

Instead of negotiating the deal directly, it can be routed through the Discount and Finance House

of India (DFHI), the borrowers and lenders inform the DFHI about their fund requirement and

availability at a specified rate of interest. Once the deal is confirmed, the Deal settlement advice

is lender and receives RBI cheque for the money borrowed. The reverse is taking place in the

case of landings by the DFHI. The duly discharged call deposit receipt is surrendered at the time

of settlement. Call loans can be renewed on the back of the deposit receipt by the borrower.

Call loan market transitions and participants:

In India, call loans are given for the following purposes:

1. To commercial banks to meet large payments, large remittances to maintain liquidity with theRBI and so on.

2. To the stock brokers and speculators to deal in stock exchanges and bullion markets.3. To the bill market for meeting matures bills.4. To the Discount and Finance House of India and the Securities Trading Corporation of India to

activate the call market.

5. To individuals of very high status for trade purposes to save interest on O.D or cash credit.The participants in this market can be classified into categories viz.

1. Those permitted to act as both lenders and borrowers of call loans.2. Those permitted to act only as lenders in the market.

The first category includes all commercial banks. Co-operative banks, DFHI and STCI. In the

second category LIC, UTI, GIC, IDBI, NABARD, specified mutual funds etc., are included.

They can only lend and they cannot borrow in the call market.


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Advantages of call money:

In India, commercial banks play a dominant role in the call loan market. They used to borrow

and lend among themselves and such loans are called inter-bank loans. They are very popular in

India. So many advantages are available to commercial banks. They are as follows:

High Liquidity: Money lent in a call market can be called back at any time when needed. So, itis highly liquid. It enables commercial banks to meet large sudden payments and remittances

by making a call on the market.

High Profitability: Banks can earn high profiles by lending their surplus funds to the callmarket when call rates are high volatile. It offers a profitable parking place for employing the

surplus funds of banks temporarily.

Maintenance Of SLR: Call market enables commercial bank to minimum their statutoryreserve requirements. Generally banks borrow on a large scale every reporting Friday to meet

their SLR requirements. In absence of call market, banks have to maintain idle cash to meet5

their reserve requirements. It will tell upon their profitability.

Safe and Cheap: Though call loans are not secured, they are safe since the participants have astrong financial standing. It is cheap in the sense brokers have been prohibited form operating

in the call market. Hence, banks need not pay brokers on call money transitions.

Assistance To Central Bank Operations: Call money market is the most sensitive part of anyfinancial system. Changes in demand and supply of funds are quickly reflected in call money

rates and give an indication to the central bank to adopt an appropriate monetary policy.

Moreover, the existence of an efficient call market helps the central bank to carry out its open

market operations effectively and successfully.

Drawbacks of call money:

The call market in India suffers from the following drawbacks:

Uneven Development: The call market in India is confined to only big industrial andcommercial centers like Mumbai, Kolkata, Chennai, Delhi, Bangalore and Ahmadabad.


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Generally call markets are associated with stock exchanges. Hence the market is not evenly

development.

Lack Of Integration: The call markets in different centers are not fully integrated. Besides, alarge number of local call markets exist without an\y integration.

Volatility In Call Money Rates: Another drawback is the volatile nature of the call moneyrates. Call rates very to greater extant indifferent centers indifferent seasons on different days

within a fortnight. The rates very between 12% and 85%. One cannot believe 85% being

charged on call loans.

Commercial Bills Market or Discount Market:A commercial bill is one which arises out of a genuine trade transaction, i.e. credit

transaction. As soon as goods are sold on credit, the seller draws a bill on the buyer for the

amount due. The buyer accepts it immediately agreeing to pay amount mentioned therein after a

certain specified date. Thus, a bill of exchange contains a written order from the creditor to the

debtor, to pay a certain sum, to a certain person, after a creation period. A bill of exchange is a

self-liquidating paper and negotiable/; it is drawn always for a short period ranging between 3

months and 6 months.

Definition of a bill:

Section 5 of the negotiable Instruments Act defines a bill exchange a follows:

an instrument in writing containing an unconditional order, signed by the maker, directing

a certain person to pay a certain sum of money only to, or to the order of a certain person ort to

the beater of the instrument.

Types of Bills:

Many types of bills are in circulation in a bill market. They can be broadly classified as follows:

1.

Demand and ursine bills.2. Clean bills and documentary bills.3. Inland and foreign bills.4. Export bills and import bills.5. Indigenous bills.6. Accommodation bills and supply bills.


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7. Demand and Ursine BillsDemand bills are others called sight bills. These bills are payable immediately as soon

as they are presented to the drawee. No time of payment is specified and hence they are payable

at sight. Usince bills are called time bills. These bills are payable immediately after the expiry of

time period mentioned in the bills. The period varies according to the established trade custom or

usage prevailing in the country.

Clean Bills and Documentary Bills

When bills have to be accompanied by documents of title to goods like Railways,

receipt, Lorry receipt, Bill of Lading etc. the bills are called documentary bills. These bills can be

further classified into D/A bills and D/P bills. In the case of D/A bills, the documents

accompanying bills have to be delivered to the drawee immediately after acceptance. Generally

D/A bills are drawn on parties who have a good financial standing. On the order hand, the

documents have to be handed over to the drawee only against payment in the case of D/P bills.The documents will be retained by the banker. Till the payment o0f such bills. When bills are

drawn without accompanying any documents they are called clean bills. In such a case,

documents will be directly sent to the drawee.

Inland and Foreign Bills

Inland bills are those drawn upon a person resident in India and are payable in India.

Foreign bills are drawn outside India an they may be payable either in India or outside India.

They may be drawn upon a person resident in India also. Foreign boils have their origin outside

India. They also include bills drawn on India made payable outside India.

Export and Foreign Bills

Export bills are those drawn by Indian exports on importers outside India and import

bills are drawn on Indian importers in India by exports outside India.

Indigenous Bills

Indigenous bills are those drawn and accepted according to native custom or usage of

trade. These bills are popular among indigenous bankers only. In India, they called hundis thehundis are known by various names such as Shah Jog, Nam Jog, Jokhani, Termainjog.

Darshani, Dhanijog, and so an.


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Accommodation Bills and Supply Bills

If bills do not arise out of genuine trade transactions, they are called accommodation

bills. They are known as kite bills or wind bills. Two parties draw bills on each other purely

for the purpos4 of mutual financial accommodation. These bills are discounted with bankers and

the proceeds are shared among themselves. On the due dates, they are paid. Supply bills arethose neither drawn by suppliers or contractors on the government departments for the goods nor

accompanied by documents of title to goods. So, they are not considered as negotiable

instruments. These bills are useful only for the purpose of getting advances from commercial

banks by creating a charge on these bills.

Operations in Bill Market:

From the operations point of view, the bill market can be classified into two viz.

Discount Market Acceptance Market

Discount Market

Discount market refers to the market where short-term genuine trade bills are

discounted by financial intermediaries like commercial banks. When credit sales are effected, the

seller draws a bill on the buyer who accepts it promising to pay the specified sum at the specified

period. The seller has to wait until the maturity of the bill for getting payment. But, the presence

of a bill market enables him to get payment immediately. The seller can ensure payment

immediately by discounting the bill with some financial intermediary by paying a small amount

of money called Discount rate on the date of maturity, the intermediary claims the amount of

the bill from the person who has accept6ed the bill.

In some countries, there are some financial intermediaries who specialize in the field of

discounting. For instance, in London Money Market there are specialise in the field discounting

bills. Such institutions are conspicuously absent in India. Hence, commercial banks in India have

to undertake the work of discounting. However, the DFHI has been established to activate this

market.

Acceptance MarketThe acceptance market refers to the market where short-term genuine trade bills are

accepted by financial intermediaries. All trade bills cannot be discounted easily because the

patties to the bills may not be financially sound. In case such bills are accepted by financial

intermediaries like banks, the bills earn a good name and reputation and such bills can readily

discounted anywhere. In London, there are specialist firms called acceptance house which accept

bills drawn by trades and import greater marketability to such bills. However, their importance


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has declined in recent times. In India, there are no acceptance houses. The commercial banks

undertake the acceptance business to some extent.

Advantages of commercial bills:

Commercial bill market is an important source of short-term funds for trade andindustry. It provides liquidity and activates the money market. In India, commercial banks lay a

significant role in this market due to the following advantages:

Liquidity: Bills are highly liquid assets. In times of necessity, bills can be converted into cashreadily by means of rediscounting them with the central bank. Bills are self-liquidating in

character since they have fixed tenure. Moreover, they are negotiable instruments and hence

they can be transferred freely by a mere delivery or by endorsement and delivery.

Certainty Of Payment: Bills are drawn and accepted by business people. Generally, businesspeople are used to keeping their words and the use of the bills imposes a strict financial

discipline on them. Hence, bills would be honored on the due date.

Ideal Investment: Bills are for periods not exceeding 6 months. They represent advances for adefinite period. This enables financial institutions to invest their surplus funds profitably by

selecting bills of different maturities. For instance, commercial banks can invest their funds on

bills in such a way that the maturity of these bills may coincide with the maturity of their fixed

deposits.

Simple Legal Remedy: In case the bills are dishonored\, the legal remedy is simple. Suchdishonored bills have to be simply noted and protested and the whole amount should be debited

to the customers accounts.

High And Quick Yield: The financial institutions earn a high quick yield. The discount isdedicated at the time of discounting itself whereas in the case of other loans and advances,

interest is payable only when it is due. The discounts rate is also comparatively high.

Easy Central Bank Control: The central bank can easily influence the money market bymanipulating the bank rate or the rediscounting rate. Suitable monetary policy can be taken by

adjusting the bank rate depending upon the monetary conditions prevailing in the market.

Drawbacks of commercial bills:

In spite of these merits, the bill market has not been well developed in India. The

reasons for the slow growth are the following:

Absence Of Bill Culture: Business people in India prefer O.D and cash credit to bill financingtherefore, banks usually accept bills for the conversion of cash credits and overdrafts of their

customers. Hence bills are not popular.


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Absence Of Rediscounting Among Banks: There is no practice of re-discounting of billsbetween banks who need funds and those who have surplus funds. In order to enlarge the

rediscounting facility, the RBI has permitted financial institutions like LIC, UTI, GIC and

ICICI to rediscount genuine eligible trade bills of commercial banks. Even then, bill financial is

not popular.

Stamp Duty: Stamp duty discourages the use of bills. Moreover, stamp papers of requireddenomination are not available.

Absence Of Secondary Market: There is no active secondary market for bills. Rediscountingfacility is available in important centers and that too it restricted to the apex level financial

institutions. Hence, the size of the bill market has been curtailed to a large extant.

Difficulty In Ascertaining Genuine Trade Bills: The financial institutions have to verify thebills so as to ascertain whether they are genuine trade bills and not accommodation bills. For

this purpose, invoices have to be scrutinized carefully. It involves additional work.

Limited Foreign Trade: In many developed countries, bill markets have been establishedmainly for financing foreign trade. Unfortunately, in India, foreign trade as a percentage to

national income remains small and it is reflected in the bill market also.

Absence Of Acceptance Services: There is no discount house or acceptance house in India.Hence specialized services are not available in the field of discounting or acceptance.

Attitude Of Banks: Banks are shy rediscounting bills even the central bank. They have atendency to hold the bills till maturity and hence it affects the velocity of circulation of bills.

Again, banks prefer to purchase bills instead of discounting them.

Bill Market Schemes:

The development of bills discounting as a financial service depends upon the

existence of a full fledged bill market. The Reserve Bank of India (RBI) has constantly

endeavored to develop the commercial bills market. Several committees set up to examine the

system of bank financing, and the money market had strongly recommended a gradual shift to

bills finance and phase out of the cash credit system. The most notable of these were: (1) Dehejia

Committee, 1969, (2) Tandon Committee, 1974, (3) Chore Committee, 1980 and (4) Vaghul

Committee, 1985.This section briefly outlines the efforts made by the RBI in the direction of the

development of a full fledged bill market.


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Bill Market Scheme, 1952 :

The salient features of the scheme were as follows:

(1) The schemes was announced under section 17(4)(c) of RBI Act enables it tomake advances to scheduled banks against the security of issuance of promissory

notes or bills drawn on and payable in India and arising out of bonafide

commercial or trade transaction bearing two or more good signatures one of

which should be that of scheduled bank and maturing within 90 days from the

date of advances.

(2)The scheduled banks were required to convert a portion of the demand promissorynotes obtained by them, from their constituents in respect of loans/overdrafts and

cash credits granted to them into usance promissory notes maturing within 90

days, to be able to avail of refinance under the scheme;

(3)The existing loan, cash credit or overdraft accounts were, therefore, required to besplit up into two parts viz.,

(A) one part was to remain covered by the demand promissory notes, in thisaccount further withdrawals or repayments were as usual being permitted.

(B) the other part, which would represent the minimum requirement of theborrower during the next three months would be converted into usance

promissory notes maturing within ninety days.

(4) This procedure did not bring any change in offering the same facilities as offeredbefore by the banks to their constituents. Banks could lodge the usance

promissory notes with the RBI for advances as eligible security for borrowing so

as to replenish their loanable funds.

(5)The amount advanced by the RBI was not to exceed the amount lent by thescheduled banks to the respective borrowers.

(6) The scheduled bank applying for accommodation had to certify that the paperpresented by it as collateral arose out of bona fide commercial transactions and

that the party was creditworthy.


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Bill Market Scheme, 1970:

In pursuance of the recommendations of the Dehejia Committee, the RBI constituted a working

group to evolve a scheme to enlarge the use of bills. Based on the scheme suggested by the study

group, the RBI introduced, with effect from November 1, 1970 the new bill market scheme in

order to facilitate the re-discounting of eligible bills of exchange by banks with it. To popularize

the use of bills, the scope of the scheme was enlarged, the number of participants was increased,

and the procedure was simplified over the years.

The salient features of the scheme are as follows:

Eligible Institutions: All licensed scheduled banks and those which do not require a

license (i.e. the State Bank of India, its associate banks and nationalized banks) are eligible to

offer bills of exchange to the RBI for rediscount. There is no objection to a bill, accepted by such

banks, being purchased by others banks and financial institutions but the RBI rediscounts only

those bills as are offered to it by an eligible bank.

Eligibility of Bills: The eligibility of bills offered under the scheme to the RBI is determined by

the statutory provisions embodied in section 17(2)(a) of the Reserve Bank of India Act, which

authorize the purchase, sale and rediscount of bills of exchange and promissory notes, drawn on

and payable in India and arising out of bona fide commercial or trade transactions, bearing two

or more good signatures one of the which should be that of a scheduled bank or a state

cooperative bank ands maturing:

(1) In the case of bills of exchange and promissory notes arising out of any such transactionrelating to the export of goods from India, within one hundred and eighty days

(2) In any other case, within ninety days from the date of purchase or rediscount

exclusive of days of grace;

(3) The scheme is confined to genuine trade bills arising out of genuine sale of goods.

The bill should normally have a maturity of not more than 90 days. A bill having a

maturity of 90 to 120 days is also eligible for rediscount, provided at the time of offering

to the RBI for rediscount it has a usance not exceeding 90 days. The bills presented for


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rediscount should bear at least two good signatures. The signature of a licensed scheduled

bank is treated as a good signature;

(4) Bill of exchange arising out of the sale of commodities covered by the selective credit

control directives of the RBI has been excluded from the scope of the scheme, to

facilitate the selective credit controls and to keep a watch on the level of outstanding

credit against the affected commodities.

Treasury Bill markets:Just like commercial bills which represent commercial debt, treasury bills

represent short-term borrowings of the Government. Treasury bill market refers to the market

where treasury bills are bought and sold. Treasury bills are very popular and enjoy higher degree

o9f liquidity since they are issued by the government.

Meaning and Features of Treasury Bills:

A treasury bills nothing but promissory note issued by the Government under

discount for a specified period stated therein. The Government promises to pay the specified

amount mentioned therein to the beater of the instrument on the due date. The period does not

exceed a period of one year. It is purely a finance bill since it does not arise out of any trade

transaction. It does not require any grading or endorsement or acceptance since it is clams

against the Government. Treasury bill are issued only by the RBI on behalf of the Government.

Treasury bills are issued for meeting temporary Government deficits. The Treasury bill rate of

discount is fixed by the RBI from time-to-time. It is the lowest one in the entire structure of

interest rates in the country because of short-term maturity and degree of liquidity and security.

Types of Treasury Bills:

In India, there are two types of treasury bills viz. (I) ordinary or regular and (ii) ad

hoc known as ad hocs ordinary treasury bills are issued to the public and other financial

institutions for meeting the short-term financial requirements of the Central Government. These


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Institutional investors like commercial banks, DFHI, STCI, etc, maintain a subsidiary General

Ledger (SGL) account with the RBI. Purchases and sales of TBs are automatically recorded in

this account invests who do not have SGL account can purchase and sell TBs though DFHI. The

DFHI does this function on behalf of investors with the helps of SGL transfer forms. The DFHI

is actively participating in the auctions of TBs. It is playing a significant role in the secondary

market also by quoting daily buying and selling rates. It also gives buy-back and sell-back

facilities for periods upto 14 days at an agreed rate of interest to institutional investors. The

establishment of the DFHI has imported greater liquidity in the TB market.

The participants in this market are the followers:

1. RBI and SBI2. Commercial banks3. State Governments4. DFHI5. STCI6. Financial institutions like LIC, GIC, UTI, IDBI, ICICI, IFCI, NABARD, etc.7. Corporate customers8. Public

Through many participants are there, in actual practice, this market is in the hands at the banking

sector. It accounts for nearly 90 % of the annual sale of TBs.

Importance of Treasury Bills:

Safety: Investments in TBs are highly safe since the payment of interest and repayment ofprincipal are assured by the Government. They carry zero default risk since they are issued by

the RBI for and on behalf of the Central Government.

Liquidity: Investments in TBs are also highly liquid because they can be converted into cash atany time at the option of the inverts. The DFHI announces daily buying and selling rates for

TBs. They can be discounted with the RBI and further refinance facility is available from the

RBI against TBs. Hence there is a market for TBs.


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Ideal Short-Term Investment: Idle cash can be profitably invested for a very short period inTBs. TBs are available on top throughout the week at specified rates. Financial institutions can

employ their surplus funds on any day. The yield on TBs is also assured.

Ideal Fund Management: TBs are available on top as well through periodical auctions. Theyare also available in the secondary market. Fund managers of financial institutions build

portfolio of TBs in such a way that the dates of maturities of TBs may be matched with the

dates of payment on their liabilities like deposits of short term maturities. Thus, TBs help

financial managers it manage the funds effectively and profitably.

Statutory Liquidity Requirement: As per the RBI directives, commercial banks have tomaintain SLR (Statutory Liquidity Ratio) and for measuring this ratio investments in TBs are

taken into account. TBs are eligible securities for SLR purposes. Moreover, to maintain CRR

(Cash Reserve Ratio). TBs are very helpful. They can be readily converted into cash and

thereby CRR can be maintained.

Source Of Short-Term Funds: The Government can raise short-term funds for meeting itstemporary budget deficits through the issue of TBs. It is a source of cheap finance to the

Government since the discount rates are very low.

Non-Inflationary Monetary Tool: TBs enable the Central Government to support itsmonetary policy in the economy. For instance excess liquidity, if any, in the economy can be

absorbed through the issue of TBs. Moreover, TBs are subscribed by investors other than the

RBI. Hence they cannot be mentioned and their issue does not lead to any inflationary pressure

at all.( Recommended reading: Treasury bills and inflation control )

Hedging Facility: TBs can be used as a hedge against heavy interest rate fluctuations in thecall loan market. When the call rates are very high, money can be raised quickly against TBs

and invested in the call money market and vice versa. TBs can be used in ready forward

transitions.

Defects of Trasury Bills:

Poor Yield: The yield form TBs is the lowest. Long term Government securities fetch moreinterest and hence subscriptions for TBs are on the decline in recent times.
http://www.mbaknol.com/investment-management/investment-management/treasury-bills-and-inflation-control/http://www.mbaknol.com/investment-management/investment-management/treasury-bills-and-inflation-control/


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Absence Of Competitive Bids: Though TBs are sold through auction in order to ensure marketrates for the investors, in actual practice, competitive bids are competitive bids are

conspicuously absent. The RBI is compelled to accept these non-competitive bids. Hence

adequate return is not available. It makes TBs unpopular.

Absence Of Active Trading: Generally, the investors hold TBs till maturity and they do notcome for circulation. Hence, active trading in TBs is adversely affected.

Money Market Instruments:

A varity of instruments are available in developed money market. In india ,till 1986 ,only a few

instruments were available. they were:

i. Treasury bills in the treasury market.ii. Money at call and short notice in the call loan market.

iii. Commercial bills,and promissory notes in the bill market.

Now ,in addition to the above ,the following new instruments are available:

1. Commercial papers2. Certificate of deposit3. Inter-bank participation certificates.4. Repo instruments.

1) Commercial papers

Commercial paper is a type of fixed-maturity unsecured short-term negotiable debt issued

generally in bearer form and primarily by non-banks. At the beginning of the 1980s issuance of

commercial paper was confined to the United States, Canada and Australia. The years which

followed saw the opening of commercial paper markets in several countries and the

establishment of a market for Euro-commercial paper. Although the US market has been the

model for several of these new markets, there are many significant differences in the way in

which each is organised, the characteristics of the instruments traded, the type of issuer and the

nature of the regulations applicable.


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What is a commercial paper?

An unsecured obligation issued by a corporation or bank to finance its short-

term credit needs, such as accounts receivable and inventory. Maturities typically range from 2 to

270 days. Commercial paper is available in a wide range of denominations, can beeither discounted or interest-bearing, and usually have a limited or nonexistent secondary market.

Commercial paper is usually issued by companies with highcredit ratings, meaning that

the investment is almost always relatively low risk.

Issuers :

All private sector company,publics sector units,non-banking company etc.

Investors:

Individuals,banks,corporates and also NRIs. Usualy banks,large corporate bodies and

public sector units with investible funds participate in CP market.

Features of Commercial Paper

1. Commercial paper is a short-term money market instrument comprising usince promissory notewith a fixed maturity.

2. It is a certificate evidencing an unsecured corporate debt of short term maturity.3. Commercial paper is issued at a discount to face value basis but it can be issued in interest

bearing form.

4. The issuer promises to pay the buyer some fixed amount on some future period but pledge noassets, only his liquidity and established earning power, to guarantee that promise.

5. Commercial paper can be issued directly by a company to investors or through banks/merchantbanks.

Advantages of Commercial Paper

Simplicity: The advantage of commercial paper lies in its simplicity. It involves hardly anydocumentation between the issuer and investor.


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Flexibility: The issuer can issue commercial paper with the maturities tailored to match thecash flow of the company.

Easy To Raise Long Term Capital: The companies which are able to raise funds throughcommercial paper become better known in the financial world and are thereby placed in a more

favorable position for rising such long them capital as they may, form time to time, as require.

Thus there is in inbuilt incentive for companies to remain financially strong.

High Returns: The commercial paper provides investors with higher returns than they couldget from the banking system.

Movement of Funds: Commercial paper facilities securitization of loans resulting in creationof a secondary market for the paper and efficient movement of funds providing cash surplus to

cash deficit entities.

Commercial Paper Market in Other Countries

The roots of commercial paper can be traced way back to the early nineteenth century when the

firms in the USA began selling open market paper as a substitute for bank loan needed for short

term requirements but it developed only in 1920s. The development of consumer finance

companies in the 1920s and the high coat of bank credit resulting from the incidence of

compulsory reserve requirements in the 1960s contributed to the popularity of commercial paper

in the USA. Today, the US commercial paper market is the largest in the worlds. The

outstanding amount at the end of 1990 in the US commercial paper market stood at $557.8

billion. The commercial paper issues in the US are exempted from requirement if issue of

prospectus so long as proceeds are used to finance current transitions and the papers mortuary is

less than 270 days.

Most of the commercial paper market in Europe is modeled on the lines of the US market. In the

UK the Sterling Commercial Paper Market was launched in May 1986. In the UK, the borrower

must be listed in the stock exchange and he must met assets of least $50 million. However,

rating by credit agencies is not required. The maturities of commercial paper must be between 7

and 364 days. The commercial paper is exempted form stamp duty.


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In finance, commercial papers were thought of as a fixable alternative to bank loans. The

commercial paper was introduced in December 1985. Commercial paper can be issued only by

non-bank French companies and subsidiaries of foreign companies. The papers are in bearer

form. It can be either issued by dealers or placed directly. The maturity ranges form ten days to

seven years. Rating by credit agencies is essential. To protect investors. Law contains fairly

extensive disclosure requirements and requires publication of regular finance statements by

issue. The outstanding amount at the end of 1990 in France Commercial paper market was $31

billion.

The Canadian commercial paper market was launched in 1950s. The commercial paper is

generally used for terms of 30days to 365 days although terms such as overnight are available.

The commercial paper issued by Canadian companies is normally secured by pledge of assets.

The outstanding amount at the end of 1990 in the commercial market was $26.8 billions.

In Japan, the yen commercial paper market was opened in November 1987. The commercial

paper issues carry maturities from two weeks to nine months. Japan stands second in the

commercial paper market in the world an outstanding amount of $117.3 billions in 1990.

In 1980s many other countries launched commercial paper market, notably Sweden (early

1980s), Spain (1982s), Hong Kong (1982), Singapore (1984), Norway (1984).

Commercial Paper in India

In India, on the recommendations of the Vaghul working Group, the RBI announced on

27th March 1989, that commercial paper will be introduced soon in Indian money market. The

recommendations of the Vaghul Working Group on introduction of commercial paper in Indian

money market are as flowers:

1. There is a need have limited introduction of commercial paper. It should be carefully plannedand the eligibility criteria for the issuer should be sufficiently rigorous to ensure that the

commercial paper market develops on healthy lines.

2. Initially, access to the commercial paper market should be registered to rated companies havinga net worth of Rs. 5 cores and above with good dividend payment record.


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3. The commercial paper market should function within the overall discipline of CAS. The RBIwould have to administer the entry on the market, the amount if each issue the total quantum

that can be raised in a year.

4. Ni restriction be placed on the commercial paper market except by way of minimum size ofnote. The size of single issue should not be less than Rs. 1 core and the size of each lot should

not be less than Rs. 5 lakhs.

5. Commercial paper should be excluded from the stipulations on insecure advances in the case ofbanks.

6. Commercial paper would not be tied to any transaction and the maturity period may be 7 daysand above but not exceeding six months, backed up if necessary by a revolving underwriting

facility of less than three years .

7. The using company should have a net worth of net less than Rs. 5 cores, a debt quality ratio ofnot more than 105, current ratio of more than 1033, a debt servicing ratio closer to 2, and be

listed on the stock exchange.

8. The interest rate on commercial paper would be market dominated and the paper could be issuedat a discount to face value or could be interest bearing.

9. Commercial paper should not be subject to stamp duty at the time of issue as well as at the timetransfer by endorsement and delivery.

On the recommendations of the Vaghul Working Group, the RBI announced on 27 th March,

1989 that commercial paper will be introduced soon in Indian money market. Detailed guidelines

were issued in December 1989, through non-Banking companies (acceptance of Deposits

through commercial paper) Direction, 1989 and finally the commercial papers were instructed in

India from 1st January, 1990.

RBI Guidelines on Commercial Paper Issue

The important guidelines are:

1. A company can issue commercial paper only if it has:1. A tangible net worth of not less than Rs. 10croes as per the latest balance sheet;2. Minimum current ratio of 1.33:1,3. A fund based working capital limit of Rs. 25 crores or more.;


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4. A debt servicing ratio closer to 2;5. The company is listed on a stock exchange;6. Subject to CAS discipline;7. It is classified under Health Code no. 1 by the financing banks;8. The issuing company would need to obtain p1 from CRISIL;

2. Commercial paper shall be issued in multiples of Rs. 25 lakhs but the minimum amount to beinvested by a single investor shall be Rs. 1 crore.

3. The commercial paper shall be issued for minimum maturity period of 7 days and the maximumperiod of 6 months from the date of issue. There will be no grace period on maturity.

4. 0the aggregate amount shall not exceed 20% of the issuers fund based working capital.5. The commercial paper is issued in the form of usince promissory notes, negotiable by

endorsement and delivery. The rate of discount could be freely determined by the issuing

company. The issuing company has to bear all flotation cost, including stamp duty, dealers, fee

and credit rating agency fee.

6. The issue of commercial paper cannot be underwritten or co-opted in any manner. However,commercial banks can provide standby facility for redemption of the paper on the maturity date.

7. Investment in commercial paper can be made by any person or banks or corporate bodiesregistered or incorporated in India and un-incorporated bodies too. Non-resident Indians can

invest in commercial paper on non-repatriation basis.

8. The companies issuing commercial paper would be required to ensure that the relevantprovisions of the various statutes such as companies Act, 1956, the IT At, 1961 and the

Negotiable Instruments Act, 1981 are complied with.

Procedure and Time Frame Doe Issue Commercial Paper

1. Application to RBI through financing bank or leader of consortium bank for working capitalfacilities together with a certificate from credit rating agency.

2. RBI to communicate in writing their decision on the amount of commercial paper to be issued tothe leader bank.

3. Issue of commercial paper to be completed within 2 weeks from the date of approval of RBIthrough private placement.


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4. The issue may be spread shall bear the same maturity date.5. Issuing company to advise RBI through the bank/leader of the bank, the amount of actual issue

of commercial paper within 3 days of completion of the issue.

Implications of Commercial Paper

The issue of commercial paper is an important step in disintermediation bringing a large number

of borrowers as well as investors in touch with each other, without the intervention of the

banking system as financial intermediary. Directly from borrowers can get at least 20% of their

working capital requirements directly from market at rates which can be more advantageous than

borrowing through a bank. The forts class borrowers have the prestige of joining the elitist

commercial paper club with the approval of CRISIL, the banking system and the RBI, however

RBI has presently stipulated that the working capital limits of the banks will be reduced to the

extent of issue of commercial paper, industrialists have already made a plea that the issue of

commercial paper should be outside the scheme of bank finance and other guidelines such as

recommendation of banks and approval of RBI has not accepted the plea at present as

commercial paper is a unsecured borrowing and not related to a trade transaction. The main aim

of the RBI is to ensure that commercial paper develops a sound money market instrument.si, in

the initial stages emphasis should be on the quality rather than quantity.

Impact on commercial banks

The impact of issue of commercial paper on commercial banks would be of two dimensions. One

is that banks themselves can invest in commercial paper and show this as short term investment.

The second aspect is that the banks are likely to lose interest on working capital loan which has

been hitherto lent to the companies, which have, now started borrowing through commercial

paper.

Further, the larger companies might avail of the cheap funds available in the market during the

slack season worsening the banks surplus fund position\, but come to the banking system for

borrowing during the busy season when funds are costly. This would mean the banks are the

losers with a clear impact on profitability.


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However, the banks stand to gain by charging higher interest rate on reinstated portion especially

of it done during busy season and by way of service charge for providing standby facilities and

issuing and paying commission. Further when large borrowers are able to borrow directly from

the market, banks will correspondingly be freed from the pressure on resources.

Impact on the Economy

The process of disintermediation is taking place in the free economies all over the world. With

the introduction of CP financial disintermediation has been gaining momentum in the Indian

economy. If CPs are allowed to free play, large companies as well as banks would learn to

operate in a competitive atmosphere with more efficiently. This result greater excellence in the

service of banks as well as management of finance by companies.

Recent trends

RBI has liberalized the terms of issues of CP from May 30, 1991. According to the liberalizedterms, proposal by eligible companies for the issues of CP would not require the approval of

RBI. Such companies would have to submit the proposal to the financing bank which provided

working capital facility either as a sole bank or as a leader of the consortium. The bank, on

being satisfied of the compliance of the norms would take the proposal on record before the

issue of commercial paper.

RBI has further relaxed the rules in June 1992, the minimum working capital limit required bya company to issue CP has been reduced to Rs. 5 crores. The ceiling on amount of which can

be raised through CP has been raised to 75% of working capital. A closely held company has

also been permitted to borrow through CPs provided all the criteria are met. The minimum

rating required from CRISIL has been lowered to P2 from 1994 95, the standby facility by

banks for CP has been abolished. When CPs are issued, banks will have to effect a pro-rata

reduction in the criteria are met. The while minimum rating needed from ICRA is A2 instead of

A1.

According to the RBI monetary policy for the second half of 1994 95, the standby facility bybanks for CP has been abolished. When CPs are issued, banks will have to effect a pro-rata

reduction in the cash credit limit and it will be no longer necessary for banks to restore the cash


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credit limit to meet the liability on maturity of CPs. This will import a measure of

independence to CP as a money market instrument.

Future of Commercial Paper in India

Corporate enterprises requiring burgeoning funds to meet their expanding needs find it easier and

cheaper to raise funds from market by issuing commercial paper. Further, it provides greater

degree of flexibility in business finance to the issui9ng company in as much it can decide the

quantum of CP and its maturity on the basis of its future cash flows. CPs have made a good start.

Since the inception of CPs in India in January 1990, 23 companies have issued CPs worth RS.

419.4 crore till June 1991. The total issues amounted to Rs. 9,000 crore in June 1994. The

outstanding amount of CPs stood art Rs. 4,770 crore on March 31, 1999 and increased to Rs.

7,814 crore on March 31. 2000.

The issues of CPs declined to Rs. 5,663 crore on March 31, 2000. It shows that the CP market is

moribund. There is no increase in issuer base. i.e. the same companies are tapping this market for

funds. The secondary market is virtually non-existent. Only commercial banks pick these papers

and hold till mortuary. No secondary market is allowed to develop on any significant scale.

Further, trading is cumbersome as procedural requirements are onerous. The stamp duty payable

by banks subscribing charged to non-banking entities like, primary dealer, corporate and non-

banks instead of directly subscribing to them. The structural rigidities such as rating

requirements, timing of issue, terms of issue, maturity ranges denominational rang and interest

rate stand in the way of developing commercial paper market. The removal of stringent

conditions and imposing o such regulatory measures justifiable to issues, investors and dealers

will improve the potentiality of CP as a source of corporate financing.

2) Certificate of deposit(CD)A certificate of deposit ("CD") is a short to medium-term, FDIC insured investment

available at banks and savings and loan institutions. Customers agree to lend money to the

institutions for a certain amount of time. In exchange for doing so, the customers is paid a


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predetermined rate of interest. Often, banks will charge a penalty fee if the money is withdrawn

from the CD before it matures.

Issuers:

The issuers of certificate of deposits are commercial banks,financial institutions ect.

Subscribers:

CDs are available for subcription by individuals,corporation,trusts,assocation and NRIs.

Features of Certificate Of Deposit:

Document of title to time deposit. Unsecured negotiable promotes. Freely transferable by endorsement and delivery. Issued at discount to face value. Repayable on a fixed date without grace days. Subject to stamp duty like the usince promissory notes.

The banks in USA in 1960s introduced CDs which are freely negotiable and marketable any time

before maturity. The CDs were issued by big banks in the USA of $1 million at face value

bearing fixed interest with a maturity generally ranging from 1 to 6 months. Banks sold CDs

direct to investors or through dealers who subsequently traded this instrument in secondary

market. The American banks issued for the first time dollar CDs in London in 1966. The bank of

England gave permission to around 40 banks to make CD issue.

The feasibility of introducing CDs in India was examined by the Tamb Working Group in 1982

which did not, however, favour the introduction of this instrument. The matter was again studied

in 1987 by the Vaghul Working Group on the Money Market. The Vaghul Group recognized that

CP world be attractive both the banker and investor in that the bank is not required to encase the

deposit prematurely while the investor can liquefy the instrument before its maturity in the

secondary market.


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On the recommendations of the Vaghul Committee, the RBI formulated a scheme in June 1989

permitting scheduled commercial banks (excluding RRBs) to issue CDs. It terms of the scheme,

CDs can be issued by scheduled commercial banks at discount on face value and the discount

rates are market-determined. The RBI has issued detailed guidelines for the issue of CDs and ,

with the changes introduced subsequently, the scheme for CDs has been liberalized.

RBI Guidelines:

1. The denomination of CDs could be in multiples of Rs. 5 lakh subject to a minimum size of anissue to a single investor being Rs. 25 lakh. The CDs above Rs.25lakh will be in multiples of

Rs.5 lakh. The amount rates to face value (not mortuary value) of CDs issued.

2. The CDs are short-term deposit instruments with maturity period ranging from 3 months to oneyear. The banks can issues at their discretion the CDs for any member of months/ days beyond

the minimum usince period of three months and within the maximum usince of one year.

3. CDs can be issued to individuals, corporations, companies, trust funds, associations, etc. non-resident Indians (NRIs) can also subscribe to CDs but only on a non-repatriation.

4. CDs are freely transferable by endorsement and delivery but only after 45 days of the date ofissue the primary investor. As such, the maturity period of CDs available in the market can be

anywhere between 1 day and 320 days.

5. They are issued in the form of usince promissory notes payable on a fixed date without days ofgrace. CDs are subject to payment of stamp duty like the usince promissory notes.

6. Banks have to maintain CRR and SLR on the issue price of CDs and report them as deposits tothe RBI. Banks are neither permitted to grant loans against CDs nor to buy them back

prematurely.

7. From October 17, 1992, the limit for issue of CDs by scheduled commercial banks (excludingRegional Rural Banks) has been raised from 7 per cent to 10 per cent of the fortnightly

aggregate deposits in 1989 90. The ceiling on outstanding of CDs at any point of time are

prescribed by the Reserve Bank of India for each bank. Banks are advised by the RBI to ensure

that the individual bank wise limits prescribed for issue of CDs are not exceeded at any time.

At present the total permissible limits for issue of certificates of deposits (CDs). By the baking

system amounts to Rs. 15,038 crore equivalent to 10 per cent of the fortnightly average


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outstanding aggregate deposits in 1989 90. The outstanding amount of CD issued by 50

scheduled commercial banks as on February 5,1998 amounted to Rs.10,261 crore and formed

70.4 per cent of the limit set for these banks for issue of CDs. To enable banks to mobilize

deposits on comparative terms id has been decided to enhance the limits for issue of CDs .

Accordingly, with effect from April17m 1993 scheduled commercial banks (excluding Regional

Rural Banks) can issue CDs equivalent to 10 per cent of the fortnightly average outstanding

aggregate deposits inn 199192. Consequently the aggregate limits for issue of CDs by eligible

banks would increase from Rs. 15,038 crore of Rs. 20,552 crore. There financial instruments,

viz, industrial development banks in India, industrial credit and investment corporation of India

and industrial finance corporation of India, were permitted to issue CDs with a maturity

aggregate limit of Rs. 100 crore (enhanced to Rs. 1,350 crore in May 1992) . effective from July

29, 1992 the industrial reconstruction Bank of India has also been permitted by issue CDs upto a

limit of Rs. 100 crore.

Advantages of Certificate of Deposits:

1. Certificate of deposits are the most convenient instruments to depositors as they enabler theirshort term surpluses to earn higher return.

2. CDs also offer maximum liquidity as the are transferable by endorsement and delivery. Theholder can resell his certificate to another.

3. From the point of view of issuing bank,, it is vehicle to raise resource in times of need andimprove their lending capacity. The CDs are fixed term deposits which cannot be withdrawn

until the redemption date.

4. This is an ideal instrument for the banks with short term surplus found to invest at attractiverates.

3) Inter bank participations certificate:

The Working Group on the Money Market (Chairman Shri N.Vaghul) had recommended the

introduction of Inter-Bank Participations, with a view to providing an additional instrument for

evening out short term liquidity within the banking system. The said recommendation has been


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accepted and the following scheme of Participations has been framed. The salient features of

theScheme are given below:

There will be two types of Participations:

I. Inter-Bank Participations with Risk Sharing; and

II Inter-Bank Participations without Risk Sharing.

The Participations would be strictly inter bank confined to scheduled commercial banks.

I. Inter-Bank Participations with Risk SharingThe primary objective of the Participations is to provide some degree of flexibility in the credit

portfolio of banks and to smoothen the working of consortium arrangements.

1. Applicability of the Scheme

The scheme will be confined to scheduled commercial banks.

2. Period of Participations

The minimum period of such a Participation will be 91 days, while the maximum period

will be 180 days.

3. Rate of Interest

The rate of interest on Participations would be left free to be determined between the issuing

bank and the participating bank, subject to a minimum of 14.0 per cent per annum.

4. Selection of Accounts

Banks will allot such Participations only in respect of advances classified under Health Code

No. 1 status. The aggregate amount of such Participations in any account should not exceed 4

per cent of the out standings in the account at the time of issue. During the currency of the

Participations the aggregate amount of Participations should be covered by the outstanding

balance in the account. In case the outstanding balance falls short of the participations


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outstanding, the issuing bank will reduce the Participations to the extent necessary and if need

be, issue Participations for smaller amounts.

5. Accounting

In the case of the issuing bank, the aggregate amount of Participations would be reduced from

the aggregate advances outstanding. Such transactions will not be reflected in the individual

borrower's accounts but will be only netted out in the General Ledger. The participating bank

would show the aggregate amount of such Participations as part of its advances. The issuing

bank will maintain a register to record full particulars of such Participations.

There will be no privity of contract between the borrower and the participating bank and to

avoid any difficulty, banks will incorporate in the cash credit agreement of the borrowers an

appropriate clause permitting the lending bank to shift a part of the advance to any bank,

without notice to the borrowers, by way of Participations. The agreement may also provide that

in the event of issue of Participations the issuing bank would continue to represent the

participating bank in protecting the latter's interests.

6. Risk

The risk would be deemed to have crystallised when the issuing bank recalls the advances and

stops operations in the relative account. In such a case the issuing bank would give due notice to

the participating bank intimating the default.

7 . Repayment

The issuing bank will normally repay the amount of Participations together with interest to the

participant bank on the date of maturity, excepting when the risk has materialised. In cases

where risk has materialised the issuing bank will take necessary action, in consultation with the

participating bank and share the recoveries proportionately.


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8. Documentation

All banks wishing to participate in the scheme should subscribe to the "uniform code for

Participations" prepared by IBA which will spell out clearly their inter-se rights and obligations

in relation to the securities covered by the advances in question.

9. Transferability

Participations will not be transferable.

Il. Inter-Bank Participations without risk sharing

The primary objective of this type of Participation is to even out short term liquidity. The

Participation should be backed by the cash credit accounts of the borrowers.

1. Applicability of the scheme

The scheme will be confined to scheduled commercial banks only.

2. Period of Participation

The tenure of such Participations will not exceed 90 days.

3. Rate of Interest

The rate of interest would be determined by the two concerned banks subject to a ceiling of 12.5

per cent per annum.

4. Accounting

The issuing bank will show the amount of Participations as borrowing while the participating

bank will show the same under Advances to bank i.e. due from banks. The Participations would

be treated as part of the net Demand and Time Liabilities and net bank balances for purposes of

statutory reserve requirements.

5. Repayment

On the date of maturity, the issuing bank will pay the amount of Participations with interest to

the participating bank irrespective of the default if any in the advance in question.

6. Transferability

Participation will not be transferable.

7. Reporting of Data

As a result of outstanding Participations being treated as borrowings, the issuing bank should

report such borrowings in the fortnightly return under Section 42(2) of the Reserve Bank of


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India Act, 1934. The same should be done by including the amount of Participations, by the

issuing bank under 'Borrowings from banks' i.e. item l(b) in Form 'A'. The participating bank

should include the amount of Participations taken in advances to banks under item III(c) in

Form 'A'. The amount of Participations so included in the relative items of Form 'A' should be

clearly indicated as a foot-note to the return, showing separately also Participations on risk

sharing basis.

4) Repo instruments:In a repo transaction, a holder of securities sells them with an agreement to repurchase the same

after a certain period at a predetermined price which is higher than the sale price. In essence it

means that the parties exchange securities and cash with a simultaneous agreement to reverse the

transactions after a given period. Thus a repo represents a collateralized short term lending

transaction. The party which lends securities (or borrows cash) is said to be doing the repo and

the party which lends cash (or borrows securities) is said to be doing the reverse repo.

The salient features if repo transaction is as follows:

1. Repos are generally for a period not exceeding 14 days though there is norestriction on the maximum period for which a repo can be done.

2. G-secs treasury bills and select PSU and institutional bonds are the instrumentsused as collateral security for repo transaction.

3. While banks and primary dealers can do repos as well as reverse repos, otherparticipants such as institutions and corporates can only lend funds in the repo

market? Recently policy changes seek to do away with this restriction and

promote a phased expansion of the repo market. Such an expansion however,

would call for creating an enabling infrastructure such as the Clearing

Corporation and electronic settlements of transactions.

4. Repos are settled on DVP basis on the same day. So, the participants in repotransactions must hold SGL, account and current account with the RBI


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5. Repos are reported in the negotiated trade segment of the WDM segment of the

NSE.

Treasury Bills:

Treasury bills are short term debt instruments of the central government. Presently 91-day and

364 day treasury are issued. Treasury bills are sold through an auction process according to a

fixed auction calendar announced by RBI. Banks and primary dealers are the major bidders in

the competitive auction process. Provident funds and other investors can make non-competitive

bids. RBI makes allocation to non-competitive bidders at a weighted average yield arrived at on

the bass of the yields quoted by accepted competitive bids.

Treasury bills are issued at a discount and redeemed at par. Hence the implicit yield on a treasury

bill is a function of the size of the discount and the period of maturity.

Treasury bills are largely held by banks. Provident funds trusts, and mutual funds gave also in

recent years become important inverts in treasury bills. Most buyers of treasury bills hold them

till maturity and hence the secondary activity is quite limited.

Commercial Paper:

Commercial paper (CP) is an instrument of short term in secured borrowing issued by non-

banking companies. CPOs are issued at a discount and redeemed at par. CPs are meant primarily

to finance working capital needs of corporates and hence form part of the working capital limits

set by banks.

CP issues are regulated by RBI guidelines issued from time to time. According to October 2001

guidelines:

1. Corporates, all India financial institutions (FIs), Primary Dealers and SatelliteDealers can issue CPs. A corporate is eligible if its tangible net worth is at least

Rs 4 crore, if it has a sanctioned working capital limit from a bank or financial

institution ad if its borrowed account is a standard asset.

2. The minimum credit rating shall be P-2 of CRISIL or an equivalent thereof.3. The maturity period is 15 days to 1 year


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4. The denomination is Rs 5 lakh or a multiple, thereof.5. Only a scheduled banks can act as an IPA (Issuing and paying Agent)6. CP can be issued as a promissory note or in a demat form.

The RBI has mandated that all further issues of CPs should be in a demat form and that banks,

financial institutions, primary dealers and secondary dealers convert their CP holdings into

demat form from March 31, 2002 onwards. This reduces stamp duty in CP transactions.

The above discussions were pertaining to money market instruments with relative advantages.

Documents

Raja Shekar Reddy